Variable Costs and Contribution Margin

At the end of January I did the 9th edition of the Owner Earnings conference for MacDermid a subsidiary of Platform Technologies. We had a great week in Cape Coral Florida. As usual it was a great week for finance. This group was 70% international which meant that many of my typical jokes did not work as well. This is always a challenge for me. The group was great as usual and it was a much better time to hit Florida than the last class which was in July. I had some nice runs in the area during the week too.

The class is ½ in-class instruction and ½ case study. Every morning Tuesday through Friday the group presents a business case financially. For the final presentation several key executives come and participate as ‘board members’ in the review. It’s a great learning process but also pretty intense. One thing we learn in these reviews is how well we taught the material because they have to apply it immediately in the cases. We always learn things that we can be doing better in these classes. This time around the groups did not seem to have a clear picture on how increasing revenue affects costs.

Typically variable costs go up as sales increase and fixed costs do not. Usually in a profit and loss statement you see cost of goods sold (COGS) increasing proportionally with sales. One the other hand, most of sales, general, and administrative expenses (S, G, & A) are fixed. So as the training groups models their forecasts for the future you should see COGS increasing somewhat with sales but S, G, & A move up much less since the majority of that costs is fixed. As many of the teams missed this concept they got challenged by the board members on their projections for the business.

What any finance person would like to see is revenue increasing at a slightly higher rate than the increase in COGS and a much higher increase in S, G, & A. The thinking is as the business grows margins or gross profit and operating profit divided by sales should improve in a healthy business. Improving margins means more profit for each dollar of sales which is never a bad thing in any business. We will make sure to teach that concept better in the next go around.

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